Thursday, July 2, 2009

Doing Your Homework

Investors who buy stocks without reading the company's disclosures leave themselves open to risks of which they are not even aware. Consider Escalade (ESCA), a diversified producer of sporting goods and office equipment.

Escalade is cheap across a variety of metrics. It trades for just $10 million, despite having operating income exceeding $10 million in each of the years 2005, 2006 and 2007. Though the recession turned results negative in 2008, the company has cut costs aggressively and has a good chance of turning a profit in 2009. The company trades with a price to book value of just .12!

But the following tidbit from the company's annual report highlights a very important risk for shareholders:

"The Company is considering the potential for voluntary delisting of its common stock with NASDAQ".

Why might they be considering this?

"In complying with those reporting obligations and the additional requirements imposed upon public companies pursuant to the Sarbanes-Oxley Act of 2002, the Company incurs significant annual out-of-pocket costs. In addition, the time and attention required of management to comply with all such requirements is substantial."

Public companies usually have higher valuations than private companies, because the shares are more liquid, more accessible, and the reporting/compliance requirements instill a level of trust from the point of view of investors. Escalade's management doesn't appear too pleased with the current valuation, however:

"As a small public company, particularly in light of recent economic conditions, the Company has not been able to take full advantage of the potential benefits of being public yet must continue to satisfy all of the requirements to remain a public company."

The company ends this paragraph with a major understatement:

"No final decisions have been made in this regard, but such actions would have a material impact on stockholders if taken."

While the risk of delisting may not prevent some investors from being interested in a cheap-looking stock, for others this falls outside the bounds of what is considered an acceptable investment. As such, it is important that investors read a company's disclosures before deciding to invest, lest they be caught unaware of a potentially detrimental future event.

Disclosure: None


Dan said...

I agree that this is a relevant piece of information. However I wonder if this is on the whole indicates that management is pursuing all relevant strategies to maximize shareholder value. They certainly would not be alone in pursuing this strategy as detailed numerous times on this website:

optionsnut said...

Wouldn't this be a good thing? If they offered to take a company private at a current p/b of .12 wouldn't you expect that to rise?

Doesn't it require the shareholders to vote in favour of this? How many companies being taken private get offered less that current market price?


Saj Karsan said...

Hi Nut,

You may be confusing this disclosure with a management buyout. In this case, however, there is no offer to take the company private. Current shareholders would remain owners of the company, but the shares would no longer trade on an exchange, thereby reducing their liquidity.